How Life Insurance Companies Make Money

Have you ever wondered how life insurance companies make money?  I mean, it seems like a sure bet for anyone buying a life insurance policy.  After all, everyone of us will eventually die. 

Term Policies

Let’s breakdown the most common type of policy, the “Term Life” insurance policy.  The reason why they call it “Term” is because the policy expires after a certain length of time.  The terms we see most often are 5 year, 10 year, and 20 year term policies.

Most people who buy term life insurance never really think too hard about how these insurance policies actually work.  But, term life insurance policies are very carefully designed so the majority of policyholders will outlive them.   This, of course, is the business model of companies that sell term life insurance. Look at it this way:  Whenever a life insurance company sells a new policy, they are making a bet that you will live long enough for the term policy to expire.

But, so what? So then all you have to do is buy another term policy or renew the expired term policy, right?  Not so fast. Here is where the insurance companies figured out the way to win the game.

Insurance Companies Use Mathematical Geniuses to Figure Out How to Win!

Don’t ever forget that insurance companies are big business. Don’t think for a second that these insurance companies just haphazardly throw together a policy and sell it hoping for the best.  Insurance companies use actuarial science and statistics to figure out what they should charge you (the premium) and the length of time or (the term) of the policy so that if they sell a certain amount of policies, they will still make tons of profit if you happen to die while being insured.  They do this by looking at the whole pool of policyholders that they have and basically play the odds that you will survive long enough for the term life policy to expire.  If they sell thousands of policies, they will be right most of the time.  Because they have so many policyholders, even if they have to pay out the occasional million dollar life insurance policy, the rest of the policies in their pool will expire while the policy holder is still alive.

So, again, why not just renew your policy for another 10 years or 20 years.  Surely, you are likely to die in the next 20 years, right?

Here is How They Get You.

Well, what happens here is if you happen to outlive your term policy, you certainly have the choice to renew your policy, right?  Sure, but stand back for the sticker shock.   Usually it is so expensive that if you decide to renew, you are forced to take less coverage.  This is because you will now see an increased premium (now that you are older and more likely to die), and the insurance company once again, will calculate what your premium will be and how long of a term they will give you, thus, still putting the odds in favor of the insurance company to win the bet.

Furthermore, what do you think happens with all that money that you pay to your insurance company? They invest it and here is how. The investments by life insurance companies are an important part of their financial ecosystem

In spite of the fact that we will all eventually die, life insurance companies remain at the top of the most profitable companies in the world. Even though it may seem like a losing proposition to have a term life policy, most estate planners and financial advisors would agree that we all should have a life insurance policy of soe sort.

If you manage to die while your term life insurance policy is in force, your beneficiary will benefit from this.  So, actually, term life insurance is not for the dead, it’s for the living.  Many people would say it is the responsible thing to do, to have a life insurance policy.  I agree, especially if you are the breadwinner in the family. 

Instead of Term Life Insurance, Consider Universal or Whole Life.

I recommend calling a qualified agent to get yourself a life insurance policy, and make the beneficiary someone you can count on and care about.  My other piece of advice would be to buy a universal or whole life policy and get it when you are young.  These offer different types of advantages.  Finally, if you buy it when you are young, your premium will be much lower.  Although we are not life insurance agents here at FAPA, we may be able to answer some questions about property damage.